There is an oft-overlooked mechanism to create investment opportunities for projects that will green our global economy and yield safe, long-term returns.
It is green bonds.
The concept is only in its infancy. Last year, the total amount of green bonds issued globally was about $3.5 billion, nearly all of them originated by international financial institutions such as the World Bank.
“It’s very small, nascent,” said Shilpa Patel, head of strategy and metrics at the International Finance Corp., speaking at a recent Green Bond Summit hosted by Boston-based State Street Global Advisors.
The potential is enormous — just consider the Empire State Building. A $20 million investment in energy efficiency by the building owners — not with bonds — will cut the skyscraper’s energy use by more than a third, saving $4.4 million a year. That’s a 4.5-year payback — an impressive return by nearly every investment measure.
“The Empire State Building project was self-financed, but not every building owner has millions to put into a building retrofit,” said Alisa Valderrama, financial policy analyst at the Natural Resources Defense Council, in outlining the challenge. “There’s a $1.3 trillion market in energy efficiency retrofits, but there’s very little action on the ground.”
With commercial and residential buildings accounting for 40% of energy consumption, the opportunities for saving money, cutting energy use and reducing pollution are enormous.
There are lots of other ways green bonds could be used across the world.
A new Barclays/Accenture report says green bonds could provide as much as €1.4 trillion ($2 trillion) of the capital needed to meet Europe’s carbon-reduction goals by 2020.
Water-related infrastructure, a vastly undercapitalized arena in the United States and globally, is also rich with opportunity, whether for financing advanced water treatment plants for water reuse, buying land along watersheds or building groundwater recharge systems to protect overextended global water supplies.
Smart grid infrastructure, mass transit and other sustainability solutions also offer promising opportunities for fixed-income investment.
So why isn’t the green bond market taking off?
The first problem is liquidity. The small number of investors in this space means there are minimal options for buying and selling these bonds. A robust secondary market that has numerous pension funds and other institutional investors active in this arena is a must for these bonds to achieve scale.
The second problem is standards. The new green building market is thriving because there is a market-recognized standard — LEED, or Leadership in Energy and Environmental Design, designed by the non-profit U.S. Green Building Council, based in Washington — for rating new buildings on their green qualities. Its 100-point scoring system and third-party certification process gives real estate investors confidence that they can properly value a green building, thus making their projects marketable to other investors.
Green bonds lack such standards. While some bond issuers consider new, more-efficient coal plants in Eastern Europe to be green-bond worthy, others use stricter standards, such as wind and solar installations and high-performance energy efficiency projects. Until there is a broad consensus on standards and verification systems for measuring performance, the green bond market will be limited.
The third problem is policies. Forward-thinking government policies that catalyze a bigger pipeline of investible projects are desperately needed. Creating incentives for energy efficiency, smart grids and mass transit are no brainers, but it is equally important to find ways to make rainforest carbon credits and other ecosystem protection measures investible products. Making these latter categories investible means knocking down outmoded, traditional definitions of “investment.”
“How do we construct cash flows that will enable you to save forests?” asked Sean Kidney, chair and co-founder of the London-based Climate Bonds Initiative, speaking at State Street’s Green Bond Summit.
The investment community has an obvious role, too. To beat their competitors in this emerging market, finance firms should be boosting their expertise and taking a friendlier view on longer-term paybacks and other long-term benefits from investing in this space. Developing new product lines should be a high priority as well.
State Street’s summit that attracted more than 100 participants from international development banks, bond issuers and other financial firms is an encouraging sign. So, too, is the bullishness of Christopher Flensborg, head of sustainable products at Skandinaviska Enskilda Banken, Stockholm, who has helped issue more than $2 billion in some three dozen issues of green bonds for the World Bank since 2008, some of which is now being held by U.S. pension funds and other institutional investors.
Mindy Lubber is president of Boston-based Ceres, a coalition of investors and environmental groups working with companies to address sustainability challenges. She also directs the Investor Network on Climate Risk, a network of 95 investors with collective assets totaling $9.5 trillion focused on the business impacts of climate change.